Mon, Mar 13, 2023

Ten Practical Strategies for SEC-Regulated Advisers in the Wake of the Regional Banking Crisis

Kroll regulatory compliance subject matter experts, in conjunction with Kroll Institute Fellows, have been evaluating developments in the banking sector, with a particular focus on the impact that the current banking crisis will have on the registered investment adviser (RIA) community.

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Kroll regulatory compliance subject matter experts have been evaluating developments in the banking sector, with a particular focus on the impact that the current banking crisis will have on the registered investment adviser (RIA) community. We are issuing this client alert to assist RIAs in formulating a risk-based and reasonable response to mitigate the collateral impact on their clients and investors.

Kroll has identified ten practical considerations for RIAs to evaluate and, where appropriate, tailor and implement related response strategies in the immediate term. While the situation is fluid, the Federal Reserve, Treasury and Federal Deposit Insurance Corporation (collectively FED) stepped in over the weekend to stabilize the marketplace, provide a measure of liquidity, and protect customer deposits. The ramifications from the sudden demise of Silicon Valley Bank (SVB) coupled with the collapse of Signature Bank, sparked speculation over the financial prospects of several other regional banks and possible consolidation within the sector will likely cause uncertainty and volatility to continue in the near term. These developments, mostly outside the control of RIAs, should prompt firms to revisit their risk assessments and contingency plans to guard against similar shocks and stressors. The current banking crisis does not appear to have the same characteristics or scale as the broader market meltdown that occurred in 2008-2009; federal regulations and internal controls in the banking sector have significantly improved in the last 20 years. Yet, there are strategies and tactics learned from that crisis that should be considered as part of a prudent plan to protect the interest of clients and investors.

Safety of Client Assets 

Consistent with the fiduciary duty owed to clients, protection of client assets is one of the paramount responsibilities of RIAs. In the immediate wake of the current crisis, RIAs with custodial relationships with banks/custodians that have either direct or indirect exposure to the affected regional banks raised legitimate concerns over what would happen to the cash or securities that RIAs placed with those custodians on behalf of clients in the event of the custodian’s failure. Such concerns should now largely be alleviated as a result of the FED’s quick sector-stabilizing actions and by the fact that, unless ring-fencing controls are circumvented, custodial assets do not normally become part of a failed bank’s estate. RIAs should take the opportunity to evaluate whether the benefits of diversifying custodial relationships could serve to minimize the potential uncertainty and destabilizing effect on the RIA’s operations because of concerns regarding the financial viability of a single custodian.

Disclose and Communicate

No doubt, RIAs have and will continue to face, an increased number of inquiries from a variety of stakeholders. For example investors, employees, counterparties, auditors and indeed regulators. RIAs should devise a clear communication plan and remain mindful that there is no upside to making materially false or misleading statements—even if the situation is froth with uncertainty. By March 31, RIAs will file annual updates to Form ADV and may be responding to investor due diligence questionnaires or distributing marketing and fundraising materials. RIAs should consider whether enhanced risk disclosures are warranted, not only to address the impact of the general banking crisis, but more importantly to disclose fully and fairly the risks that are faced by the RIA and/or the client(s), as well as any impact on the financial condition of the adviser that would impact on its ability to fulfill its fiduciary duties.

Fraud Risk

As with prior periods of uncertainty, Kroll expects that fraudsters will seek to take advantage of weaknesses in internal controls, particularly those relating to cash movement. RIAs are therefore urged to review and strengthen cash controls to verify any purported instructions for or on behalf of clients/investors to withdraw assets, as well as the identity of the person(s) authorized to make such instructions. 

Cyber Risk

Similar to the fraud risk (described above), Kroll expects an increase in attempts at phishing, business email compromises and other efforts to breach cyber defenses. RIAs and information security officers are advised to retrain and remind their personnel on the dangers posed by miscreants who seek to capitalize on the frenzy. Prudent steps should be taken to verify the authenticity of correspondence that purport to require immediate action or that request the receiver to divulge confidential client or investor information.

Electronic Communications

To the extent that RIAs have experienced an influx of incoming text and chat messages from investors who are seeking immediate information about their accounts or the RIA’s exposure to the crisis, firms should retrain and remind their personnel about the Securities and Exchange Commission’s (SEC) stance on the RIA’s books and records obligations under the Investment Advisers Act of 1940 (Advisers Act). Unless RIAs have implemented a viable technology solution to archive and monitor such messages, the SEC is likely to view such ‘off-channel’ communications involving advisory clients or the business of the adviser to be inconsistent with the regulatory requirements—even though there may be rational arguments that at least some of those communications are not required books and records as defined by the Advisers Act. (Read Kroll’s article here on recordkeeping risks vs. regulatory obligation)

Regulatory Inquiries

In a rare Sunday press release, on March 12, 2023, the SEC Chairman stated the agency’s intent to “investigate and bring enforcement actions” if violations of federal securities are found. Similar to the regulatory response to the 2008-2009 financial crisis, Kroll’s experts expect an uptick in both investigative and examination activity, not only to evaluate the contagion impact that could affect the market more broadly, but also to identify and prosecute those who may have, for example, made materially false or misleading statements regarding risks and exposures, or who traded while in possession of material non-public information. RIAs are therefore advised to evaluate their recent trading in the securities of the banks at that are at the center of the crisis, but also those that may be “economically-linked” to those companies. That trading activity should be cross-referenced against contacts with corporate insiders, bank regulators and experts who are likely to possess material non-public information. Research files that inform trading decisions should also be maintained, consistent with the books and records obligations.

Risk Management

Firms must undertake a proactive and holistic analysis of the RIAs vulnerability and exposure to the current crisis, both from an operational and from a portfolio management standpoint. It is imperative to analyze both assets and liabilities (such as lines of credit, funding commitments, and custodial arrangements) to identify actual or potential exposure and to stress test contingency plans. Firms should also analyze working capital to ensure access to sufficient capital to satisfy short term liquidity needs. If liquidity is a concern, identify alternative sources of immediate capital. Similarly, RIAs should assess and possibly disclose the risk that counterparties or vendors may be at risk of default on obligations or at least temporarily be unable to perform critical services to the RIA or to clients.

Portfolio Management

Thus far, the most significant dislocation seems to be isolated to regional banking institutions that are connected to the technology and cryptocurrency sector. Valuation of certain companies that operate in those sectors are experiencing significant price declines, volatility and liquidity concerns. Portfolio Companies may be scrambling to address short- and long-term financing to continue operations at normal levels. RIAs that invest client funds in those sectors are advised to review and adhere to the firms’ valuation policy and CCOs are advised to test and document whether write-downs or write-offs are taken appropriately in the period where such should be recognized—particularly when adviser fees are based on valuation. Material risks that emerge because of Portfolio Companies’ liquidity squeeze should be considered for disclosure in filings and in communications with investors. (Further insight on SEC scrutiny of and rulemaking for private fund advisers available here.)

Code of Ethics

The Advisers Act requires every RIA to have, and for its defined personnel, to adhere to the firm’s Code of Ethics. Such codes typically have two basic features: i) they prohibit personnel from trading based on material non-public information and ii) they prohibit personal trading that does not comply with the firm’s pre-clearance and disclosure requirements. The risks of not complying with the Code increases exponentially in periods of high market volumes or increases in sector volatility. CCOs are advised to test and document whether firm personnel who are covered by the Code, including operating partners/advisers, are both informed of the requirements and have traded in compliance with the policies.


Of paramount important, especially during periods of uncertainty, is senior management’s obligations to properly resource, supervise and impart a strong compliance culture. Kroll previously published a recommended list of questions that front office types should ask in order to demonstrate that they are engaged and informed about the most crucial aspects of the firm’s compliance policies and procedures. In addition, the current crisis presents an opportunity to review (or design) a Crisis Management Playbook that simulates various crisis scenarios and assigns roles and responsibilities to mitigate with worse case outcomes and reputational risk.

Kroll’s experts in financial services compliance and regulation, valuation, cyber security and investigations continue to monitor market developments closely and stand ready to assist in navigating the regulatory complexities and operating dislocation caused by the current banking sector crisis. We are currently working with clients to respond to investigative and examination inquiries, Form ADV filings and matters related to compliance with the SEC’s Marketing Rule, along with a slate of ongoing and special project engagements designed to ensure that our clients operate in a compliant manner. We will continue to share insights and proven strategies to help our clients mitigate actual and potential compliance risks, as the situation warrants.


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